KLEINTOP: It's Time For Some Stock Market March Madness

Jeff Kleintop Analyzes and discusses international markets, trends and events to help U.S. investors understand their significance and financial implications. In this role, Kleintop provides research, commentary and actionable insights to Schwab’s client-facing teams and the firm’s Investor Services and Advisor Services clients through written reports, video content, conference calls, webcasts and in-person events.

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It has been a sweet sixteen weeks for the S&P 500. The broad stock market index has had only three down weeks out of the past sixteen. While this stretch is tied by the same period a year ago, it is important to note that there has not been a sixteen-week period with fewer weeks of losses in over 20 years—since the period ending September 1, 1989.

March has been maddening for investors in the past few years (2010-2012) as the S&P 500 raced higher in March only to reverse all of those gains in a pullback of about 10% that began in late March or April. It later took stocks at least five months to climb back to the peaks of March.

As the NCAA tournament gets down to its own sweet sixteen at the end of this week, it is a good time to reflect on the competing drivers of the markets that may make for an exciting showdown in the weeks and months to come.

LPL FinancialFigure 1: Stocks’ Sweet Sixteen

As we narrow down stocks’ “sweet sixteen” potential drivers this year, the four “regions” of market-moving factors vying for investor attention are: economy, policy, fundamentals, and market dynamics.

Economy

• Employment – Job growth has been picking up with more than 200,000 jobs created in three of the past four months and first-time filings for unemployment benefits have started to fall after stabilizing around 350,000 for over a year.

• Housing – The powerfully rebounding housing market, as seen in data such as housing starts and building permits, is a positive for growth.

• Confidence – Last week’s University of Michigan data showed that consumer confidence fell sharply in the preliminary reading for March to the lowest level in over a year.

• Gasoline Prices – Retail gasoline prices are back up near the “danger zone” that coincided with stock market pullbacks in each of the past few years.

Policy

• Federal Reserve – “Don’t Fight the Fed” rally is intact, but as the Federal Reserve publicly contemplates ending the latest stimulus program, the stock market may suffer the same sell-off that surrounded the ending of prior quantitative easing programs, so-called QE1 and QE2.

• Europe – With the Eurozone back in recession, an inconclusive election leaving no government in Italy, a political scandal hampering the ability to implement needed reforms in Spain, Greece unlikely to meet the terms of its own bailout, and Germany pushing hard terms on any aid ahead of its fall elections, the events in Cyprus could provide the catalyst for another Europe-driven spring slide in the world's stock markets.

• Geopolitics – The hot spots are heating up again given the power grab following the death of Chavez in Venezuela, the coming elections in Iran, different factions vying for power in war-torn Syria, and North Korea annulling its cease fire agreement.

• Fiscal Cliff – A fiscal drag on gross domestic product (GDP) of about 2%, and showdowns over the continuing resolution funding the government and the debt ceiling still to come, may weigh on investor sentiment as the recently implemented sequester threatens to halt labor market improvement with an estimated cost of 750,000 jobs, according to the Congressional Budget Office.

Fundamentals

• Earnings – Earnings are the most fundamental of all drivers of stocks. Earnings growth has been the most consistent factor driving the markets in recent years, but growth has now slowed to the low-single digits for S&P 500 companies.

• Valuations – The price-to-earnings ratio of the S&P 500, at around 15 on the past four quarters’ earnings, is well below the 17–18 seen at the end of all prior bull markets since WWII.

• Credit – Demand for credit has improved and credit spreads have narrowed; both trends are key supports to growth.

• Momentum – Stocks have been on a strong winning streak that could continue.

• Volume – Trading volume in the markets has been light this year, 10–15% below last year, traditionally seen as a sign that a trend has become vulnerable.

• Volatility – Investors have once again become net sellers of U.S. stock mutual funds in the past two weeks, according to data from the Investment Company Institute (ICI), despite strong and steady gains. A return to more volatile markets may further undermine individual investor support.

• Interest Rates – Interest rates are on the rise, potentially acting as a drag on everything from housing to the U.S. budget, but from very low levels.

There are quite a few listed here, but these certainly are not all the factors that are influencing the markets.

The key message for investors in considering these factors is: don’t be too confident in any particular outcome. Respect the complexity of the situation. This is a time for caution and taking some profits, not for indiscriminate selling. It is a time to nibble at opportunities as they emerge; it is not a time to jump in with both feet.

Investing is not a game, but it is important also to remember that forecasting is not an exact science, and many factors can affect outcomes that are hard to predict. Two years ago, the Japanese earthquake had a big impact on markets and natural disasters—despite tremendous advances in technology—are very hard to predict with any degree of accuracy. Geopolitical outcomes can also be hard to foresee as we look to the stresses in the Middle East. For example, the outcome of the Arab Spring uprisings and the changes they have led to in countries including Syria and Egypt were hard to foresee. The markets rarely offer perfect clarity on their direction because they are driven by these factors as well as many others. Even this week’s NCAA March Madness can be seen as a reminder of how it can be notoriously hard to predict winners. Historically, a team’s ranking has meant nothing after getting down to the elite eight.

These factors will play out in the markets over the course of the year, not just in the coming weeks. This means there will likely be some upsets that result in volatility and pullbacks as these factors face off against each other. In the end, we expect a positive year with many opportunities for investors.